Multiple Choice
Which of the following expenditures should be recorded as an asset?
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9. Current Liabilities
Types of Liabilities
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Which statement best describes the major drawback to the use of debt financing?
A
Debt financing results in dilution of ownership for existing shareholders.
B
Debt financing increases financial risk because interest and principal payments are required regardless of the company's profitability.
C
Debt financing does not require any collateral or creditworthiness.
D
Debt financing allows owners to retain full control over the company.
Verified step by step guidance1
Understand the concept of debt financing: Debt financing involves borrowing money from external sources, such as banks or investors, which must be repaid with interest over time.
Analyze the options provided in the question: Each statement describes a characteristic or consequence of debt financing. Evaluate each statement to determine its accuracy and relevance.
Focus on the major drawback of debt financing: The key disadvantage is the obligation to make interest and principal payments regardless of the company's profitability, which increases financial risk.
Eliminate incorrect options: For example, debt financing does not dilute ownership, as it does not involve issuing equity. Additionally, debt financing often requires collateral or creditworthiness, contrary to one of the options.
Select the correct answer: The statement that best describes the major drawback is 'Debt financing increases financial risk because interest and principal payments are required regardless of the company's profitability.'
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